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INTRODUCTION
Boeing is an American multinational corporation that manufactures and provides commercial
jetliners, military aircrafts, satellites, weapons, communication system and other military platforms and
defense systems. It is also the one of the largest defense contractor in the world. Boeing focused on the
research and development to provide excellent and unique specification of aircraft that no one can
replicate.

As the worlds largest aerospace company and leading manufacturer of commercial jetliners and
defense, space and security system, Boeing puts a lot of efforts and innovations in its products and
services. Due to customers needs and requests, Boeing has expanded its product line and services. The
long tradition of aerospace leadership and innovation has given the company the advantages. Its broad
range of capabilities includes creating new and more efficient commercial airplane, integrating military
platforms and defense systems through network-enabled solutions; and arranging innovative customer-
financing options.

Basically, Boeing is diversified into two business units: Boeing Commercial Airplanes and Boeing
Defense, Space & Security. These two units are supported by three small units which are Boeing Capital
Corporation, Share Services Group and Boeing Engineering, Operations & Technology. Each unit has its
own duties.
Boeing Commercial Airplanes is being the leader in commercial aviation by offering airplanes and
services that with characters of superior design, efficiency and value to customers around the world. In
1916, Boeing aviation pioneer, William Boeing, had built the companys first airplane which is a seaplane
for two with a range of 320 nautical miles. Since then, Boeing has defined the modern jetliner and
introduced the twin-aisle cabin, the glass cockpit and countless other innovation. Moreover, in 1997, the
merger of Boeing and McDonnell, gives the company a 70-year heritage of leadership in commercial
aviation.

Boeing Defense, Space & Security provides large scale systems that enhance air, land, sea and
space-based platforms for global military, government and commercial customers. Boeing Defense, Space
& Security tries its best to provide customers with the right solutions at the right time and the right cost.
Therefore, their strategy is to understand the enduring needs of customers and provide capability-based
solution to meet their rapidly evolving requirements.
STATEMENT OF THE PROBLEM
The leader should need to complete a valuation of the project and prove to the board if the 7E7
project would be profitable for the companys shareholder. Michael Bair, the leader of the 7E7 project,
introduced the new aircraft to the board. And presenting this new project to the board required him to
create a financial analysis regarding this project.

The following are the main problems found in the case:

1. How would Bair estimate the weighted-average cost of capital?

2. Should the board approve the 7E7?

CASE STUDY: THE BOEING 7E7

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SWOT ANALYSIS

Strengths:
Large scale operation and strong global network: Boeing is one of two major manufacturers,
equipped to produce aircraft capable of carrying more than 100 passengers for the worldwide
commercial airline industry, and the second-largest defense contractor in the US. Boeing is one of
the leading producers of commercial aircraft and offers a broad spectrum of commercial jetliners
designed to meet passenger and cargo requirements of both the US and non-US airlines.
Strong association with Federal Government: Boeing has worked with the Federal Government for
over 30 years. Its Defense, Space & Security is a $32 billion business with 64,000 employees
worldwide that combines manned and unmanned airborne capabilities, intelligence and security
systems, communications architectures and extensive large-scale integration expertise across several
diverse business areas. Boeings Defense, Space & Security strategy is to understand the enduring
needs of customers and provide capability-based solutions to meet their rapidly evolving
requirements.
Focus on Research and Development: Boeings strategy also has a strong focus on R&D activities. Its
'other' business segment principally includes the engineering, operations and technology (EO&T)
activities. EO&T is an advanced research and development organization focused on innovative
technologies, improved processes and the creation of new products. R&D expenditures involve
experimentation, design, development and related test activities for defense systems, new and
derivative jet aircrafts, including both commercial and military, advanced space and other company-
sponsored product developments. The companys R&D investment amounted to $6,506 million,
$3,768 million and $3,850 million in FY 2009, FY 2008, and FY 2007 respectively.
Diversified business offerings: Boeing is the largest aircraft manufacturer globally and delivers aircraft
to a large number of developed and developing countries. Its rank as defense contractor with
different countries is second. The designs of Boeings aircrafts are efficient. There is no fault in its
designs. Its production system is also very efficient. It also has the strength of product diversification.
It not only manufactures commercial aircraft but also manufacture aerospace and defense aircrafts.

Weaknesses:
Labor/legal proceedings: Boeing has been plagued with legal problems in the past. Its recent
problems involve a new Boeing plant in South Carolina. Boeing opened a new $750 million assembly
plant in South Carolina. The National Labor Relations Board (NLRB) is accusing Boeing of breaking the
law when it violated workers rights. The controversy is over Boeing's decision to assemble its fuel-
efficient 787 Dreamliner. The NLRB is charging Boeing with retaliating against workers in Washington
State to punish them for past strikes by building the plant in a right-to-work state where unions are
not as prominent.
Dependence on US government: Boeings contracts are subject to audits by the U.S. government
agencies for incurred and indirect costs. The company is subject to cost adjustments if any costs are
found to be improperly allocated including refunds. They are also subject to government inquiries
and investigations that could have adverse effects on their financial condition. Their government
business is also subject to specific procurement regulations and other requirements that increase
Boeings performance and compliance costs.

CASE STUDY: THE BOEING 7E7

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Opportunities:
Increased aircraft demand: Air transport throughout the world is constantly changing in response to
market opportunities and challenges. The rise of new airline business models and rapid growth of air
travel in the worlds emerging economies are stabilizing worldwide demand for airplanes. The
emerging markets are driving economic expansion. The FAA expects international traffic to grow more
rapidly than domestic travel - with U.S. airlines handling 7.8 percent more international passengers
but only 3 percent more domestic passengers. This trend is expected to continue through 2031 due
to faster economic growth in other parts of the world.
Rising global defense spending: Defense spending is a long-term recession-proof industry which
would not be affected by cyclical downturns and upturns. This funding increase allows DoD to address
its highest priorities, such as the Presidents commitment to reform defense acquisition, develop a
ballistic missile defense system that addresses modern threats, and continue to provide high quality
health care to wounded service members.

Threats:
Intense competition and pricing pressure: The commercial jet aircraft market and the airline industry
remain extremely competitive. Boeing faces aggressive international competitors, including Airbus,
who are intent on increasing their market share. Boeing Defense, Space and Security (BDS) business
also faces strong competition in all market segments, primarily from Lockheed Martin, Northrop
Grumman, Raytheon Company and General Dynamics. Non-US companies such as BAE Systems and
European Aeronautic Defense and Space Company (EADS), the parent of Airbus, continue to pursue a
strategic presence in the US market by strengthening their North American operations and partnering
with US defense companies.
Risks concerning labor issues: Boeing may experience additional work stoppages in the future, which
could adversely affect its business. The company cannot predict how stable its relationships will be
with 14 different US labor organizations and 7 different non-US labor organizations. Union actions at
suppliers can also affect the company. Work stoppages and instability in the companys union
relationships could delay the production and development of its products, which could strain
relationships with customers and cause a loss of revenues.
Uncertain airline industry: Boeings main competitor is Airbus. The competition between Boeing and
Airbus is fierce. Airbus can offer large discounts because it is subsidized by European markets. Both
have spent millions lobbying politicians for various reasons from industry regulations and funding to
contracts. With time and use, airplanes age and must be refurbished or replaced. Airlines are focusing
on refurbishing old aircraft rather than new ones which can decrease the demand as well as sales of
new aircraft. Boeing has an opportunity with its Dreamliner to capture the aging airplane market. It
may be more cost effective over the long haul for airlines to replace planes due to the fuel efficiency
and cost savings of the Dreamliner.
Change in US budgetary priorities and contracts: One of Boeings strength is its contracts with the
government. However, heavily reliance on these contracts also represents a threat. As war conditions
change, the military requirements also change. Boeing was awarded one of the biggest contracts in
military history consisting of $35 billion to build the next generation of air refueling tankers. Boeing
provides commercial aircraft to many foreign airlines and is one of the largest exporters in the U.S. It
is also one of the biggest defense contractors or the military and other government departments.
Boeing gets a lot of support from the U.S. Export-Import Bank due to its overseas sales volume.

CASE STUDY: THE BOEING 7E7

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ALTERNATIVE COURSE OF ACTION

7E7 or Dreamliner is a promising project with a concept that is customer-driven. With a higher
performance and fuel efficiency, the new aircraft is very commendable. Also, this will position Boeing in
the market and may possibly regain the taken market share by Airbus.

And just like in releasing any new product line, a proper timing should be guaranteed to ensure
success. However, in this case, external and uncontrollable factors are making things worse for 7E7 such
as the fear for global terrorism, SARS, and the weak financial condition of airlines. To help the board in
deciding whether to accept or reject the project, the weighted-average cost of capital is computed that
will be compared to the IRR.

Calculating the WACC:

Beta Asset = Beta Equity / [1 + (1-Tr) D/E]
NYSE 60 trading days estimated Beta of Boeing is 1.62
Debt to Equity ratio is 0.525
Beta Asset = 1.62 / [1 + (1-0.35) x 0.525] = 1.207828518 or 1.21
Computing for the Beta Asset of Defense
Given are:
NYSE 60 trading day Beta Equity of Lockheed Martin = 0.37
Debt/equity ratio of Lockheed Martin = 0.410
Beta Asset of defense = 0.37 / [1 + (1-0.35) x 0.41] = 0.2921437031 or 0.29
NYSE 60 trading day Beta Equity of Northrop Grumman = 0.30
Debt/equity ratio of Northrop Grumman = 0.64
Beta Asset of defense = 0.30 / [1+ (1-0.35) x 0.64] = 0.2118644068 or 0.21
Average beta of defense = (0.29 + 0.21) / 2 = 0.25
From Exhibit 10,
Percentage of revenues from Defense (Wdef) = 0.46
Percentage of revenues from Commercial Sales (Wcs) = 0.54
Computing for Beta Equity of Commercial Sales
Boeing = (commercial x Wcs) + (defense x Wdef)
1.21 = (commercial x 0.54) + (0.25 x 0.46)
asset commercial = (1.095 / 0.54) = 2.03
equity commercial =2.03*1 + (1-0.35) x 0.525 = 2.72

CASE STUDY: THE BOEING 7E7

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Computing Cost of Equity

Given are: Risk premium is 8.4%
From page 237, risk free rate is equal to 0.85%
CAPM = (Beta x Market Risk Premium) + Risk Free Rate
CAPM = (2.72 x 8.4%) + 0.85
CAPM = 23.698%
Computing WACC
WACC = (Wd) x (CD) (1- Tr) + (We) x (CE)
Where,
Weight of debt (Wd) = proportion of debt in a market- value capital structure
Cost of Debt (CD) = pretax cost of debt capital
Tax Rate (Tr) = marginal effective corporate tax rate
Weight of Equity (We) = proportion of equity in a market-value capital structure
Cost of Equity = cost of equity capital
Given are:
From Exhibit 10, Debt to Equity ratio is equal to 0.525
Tax rate is equal to 35%
From Exhibit 2, Weight of Debt (44,646 / 129,686) is equal to 34.43%
Weight of Equity (85,040 / 129,686) is equal to 65.57%
From Exhibit 11, cost of debt is computed which is 5.335%
WACC = (Wd) x (CD) (1- Tr) + (We) x (CE)
WACC = (34.43%) x (5.335%) (1-35%) + (65.57%) x (23.698%)
WACC = 16.73272493% or 16.73%

CASE STUDY: THE BOEING 7E7

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RECOMMENDATION:
Based on the data computed, it can be recommended that the board should approve such project.
As a general rule for Internal Rate of Return (IRR), the company should accept a project if the IRR is greater
than the Weighted Average Cost of Capital (WACC). The WACC can be a measure of required rate of return
and discount rate for new investment evaluation. If the IRR is greater, it means that such investment
project is earning more than what is required by the company.
The project is profitable and will add value to shareholders. Due to the downturn of the airline
industry in 2001 and market competition, Boeing needs to come up with a new project that will stimulate
their earnings. The possible solution is the manufacturing of the 7E7, which will be a mid-size plane that
will be able to fly short and long routes. It will also improve fuel economy with their new engine design.
Development and manufacturing costs will play a major factor in the decision process of accepting this
project. However, if they keep the costs low, Boeing should accept the 7E7 project. There are, however,
inherent risks in this project resulting from the design and materials used. The 7E7 is the first plane to use
a carbon body construction and employ wingtip extenders. This will add risk to the project since they have
never been used on such a large-scale project.
Also, Airbus is a close competitor. They will be coming to market with their new A380 in 2005. This
plane will be a formidable competitor to the 7E7. If Boeing falls behind regarding innovation, fuel
efficiency and all the other attributes of a long-haul airliner they will lose their market share. In order for
Boeing to compete in the aviation industry, they must take on some risk and develop this new plane. With
the economy so volatile, airlines will be looking for options that reduce their operating costs. The 7E7 will
carry more passengers per flight in a fuel-efficient manner allowing the airline companies to justify
purchasing the plane. The success of the expandable wing will also give the plane attractive versatility.
The equity market risk premium should equal the excess return expected by investors on the market
portfolio. In this case it was calculated to be 8.4%. The weighted average cost of capital (WACC) was
calculated to be 16.73%. For the project to increase shareholder wealth, the IRR of the project should at
least equal the WACC. To achieve this Boeing would have to sell at least 2,500 airliners in a 20-year period.
Boeing is expecting to reach this unit goal. The financial calculations provided in this show that there is a
very good chance that the project will increase the wealth of the shareholders. There are other risks
mentioned above that must be considered but on balance the reasons to go forward with the project
outweigh those against it.

CASE STUDY: THE BOEING 7E7